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Sunday, 13 April 2014

Dyman Associates Insurance Group of Companies: Better Insurance Against Inequality

Paying taxes is rarely pleasant, but as April
15 approaches it’s worth remembering that our tax system is a progressive one
and serves a little-noticed but crucial purpose: It mitigates some of the worst
consequences of income inequality.

If any of us, as individuals, are
unfortunate enough to have income drop significantly, the tax on that income
will plummet as well — and a direct payment, or negative tax, might even be
received from the government, thanks to the earned-income tax credit. In this
way, the tax system can be viewed as a colossal insurance system, guarding
against extreme income inequality. There are similar provisions in other
countries.

But it’s also clear that while income inequality
would be much worse without our current tax system, what we have isn’t nearly
enough. It’s time — past time, actually — to tweak the system so that it can
respond effectively if income inequality becomes more extreme.

I made this argument in 2003 in
my book “The New Financial Order” (Princeton University Press). And now there
is substantial evidence that inequality has been rising rapidly. In his
monumental new book, “Capital in the 21st Century” (Belknap Press), Thomas
Piketty of the Paris School of Economics documents a sharp increase in such
inequality over the last 25 years, not only in the United States, but also in
Canada, Britain, Australia, New Zealand, China, India, Indonesia and South
Africa, with people with the highest incomes far outstripping the rest of
society. The book is impressive in its
wealth of information but it is short on solutions.

Professor Piketty talks about
instituting a “global tax on capital” but acknowledges that it is a utopian
idea and says that “it is hard to imagine the nations of the world agreeing on
any such thing anytime soon.” He talks about raising the rate of the top tax
brackets and raising inheritance taxes but sees “little reason for optimism”
that this will happen. There have been big increases in taxes on the rich in
the past, but he points out that these tax increases were put in place only in
response to wars — specifically, World War I and World War II.

Let’s try not to have another
major war. Instead, there are some positive things we can do now. As I said in
my 2003 book, it would be wise to start amending the tax system immediately. I
suggested this fundamental reform: Taxes should be indexed to income inequality
so that they automatically become more progressive — meaning that the marginal
tax rate for the highest-income people will rise — if income inequality becomes
much worse. Ian Ayres of Yale and Aaron Edlin of the University of California,
Berkeley, made a similar argument in 2011 in The New York Times.

There is a practical reason for
starting now. If we wait until income inequality is much more severe, we will
have a whole class of new superrich who will probably feel entitled to their
wealth and will have the means to defend their interest. That’s already gone
far enough. We shouldn’t let it become more extreme.

There is also a theoretical
reason. It is what the psychologists Yaacov Trope of New York University and
Nira Liberman of Tel Aviv University called temporal construal theory. They
showed that people are more idealistic and generous when dealing hypothetically
with the distant future than they are about actions they need to take today.
That’s why it pays to ask people to decide on measures to uphold egalitarian
ideals when they don’t have to cough up the money immediately.

In a draft research paper in
2006, Leonard Burman, director of the Urban-Brookings Tax Policy Center;
Jeffrey Rohaly, also of the policy center, and I analyzed a kind of
inequality-indexed tax system. (We called it the “Rising-Tide Tax System.”)
With the benefit of hindsight, we came up with a system that could have been
put in place in 1979 — when inequality was much milder in the United States —
and that could have prevented any increase in after-tax inequality through
2006.

Though our proposal worked in
theory, we found that putting it into effect would encounter difficulties. For
the system to be effective, the top tax bracket would have had to rise to well
over 75 percent — a political nonstarter, in our view. We also believed that
there would have been negative economic effects, including more tax avoidance.
So we concluded that the proposal wasn’t ready for advocacy. We held off from
finishing and publishing that paper.

Today, though, there are some
possibilities that might alleviate, at least partially, any increasing
inequality in future years.

In testimony before the Senate
Finance Committee last month, Mr. Burman proposed a version of inequality
indexing that might be politically acceptable today. His idea was to integrate
inequality indexing with inflation indexing: Instead of just linking tax
brackets to inflation as measured by the Consumer Price Index, as we have done
for years, he proposed that the adjustments also take account of rising
inequality, if it occurred. He proposed a system to offset the loss in tax
revenue that inflation indexing would produce, in a way that would get us
closer to a target distribution of after-tax income; if inequality worsened,
higher tax brackets would bear a bit more of the burden, and people at the
bottom would bear less.

A relatively minor change like
this should be politically acceptable. It is a reframing of inflation indexing,
which is already a sacrosanct principle, and would be revenue-neutral. By 2025,
Mr. Burman argued, it could pay for a doubling of the earned-income tax credit,
“with more than $100 billion left over to adjust middle-income tax
liabilities.”

Such a plan would be a nice first
step toward making our tax system manage the risk of future increases in
inequality.